Table of Contents
Introduction
Crop Insurance is a type of insurance that farmers purchase in order to protect themselves financially and their crops against unfortunate events like droughts, floods, or even when there is a loss in revenue due to a decline in the crop’s price. Additionally, a lot of crop insurance is regulated and subsidized by the government but, it is sold through private insurance companies. In addition, this paper will cover the goals and objectives of Crop Insurance, its characteristics, and who gets affected by the insurance.
Policy Discussion
As mentioned earlier, Crop Insurance is a type of insurance that farmers purchase in order to protect themselves financially and their crops against unfortunate events like droughts, floods, or even when there is a loss in revenue due to a decline in the crop’s price. One of the key characteristics of Crop Insurance is the way it works. The Federal Government subsidizes Crop Insurance in multiple ways. One of the ways is that the farmer pays some part of the premium and the government pays the rest. How this works is that if a farmer chose to pay a lower premium amount, then the government will pay the rest however, the Crop Insurance coverage level might be less. Another way is that the government covers the insurance companies’ administration and operating expenses. Lastly, the government takes some of the losses when an insurance company has to pay the farmer the insurance money. The goal of Crop Insurance is to help out farmers financially when unfortunate events happen. However, Crop Insurance also faces some problems.
Unfortunately, another key characteristic of Crop Insurance is all the problems that can come with it. One of the problems that Crop Insurance face is Moral Risk. According to, Estimating the Extent of Moral Hazard in Crop Insurance Using Administrative Data by Michael J. Roberts, Nigel Key, and Erik O’Donoghue, “Moral hazard refers to the effect insurance contracts may have on the insured’s hidden actions.” What this means is that farmers will take more and bigger risks with their crops because they know they will be covered if something bad were to happen. This is bad because the farmer can be purposely taking bigger risks in order to lose so that the Crop Insurance companies pay up. Another problem that Crop Insurance faces is Adverse Selection. Adverse Selection is when the two parties (both buyer and seller of Crop Insurance) have different information. This becomes a problem when farmers know more about what kind of risks, they face than the Crop Insurance agency and use that information to decide if they should insure their crops. As a result, the farmer selects coverage levels or plans of insurance knowing that an indemnity (payment) is highly likely and that the premium rate the farmer pays does not reflect that expectation This is a problem because a farmer can select an insurance plan that is more likely to pay him/her. In addition, Adverse Selection usually happens when a Crop Insurance agency does not do their research in the area they want to cover. Lastly, Adverse Selection can be bad to Crop Insurance agencies because it will increase the loss of crops and it also increases the cost of running the Crop Insurance program.
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Policy Analysis
Producers of Crop Insurance face uncertainty in the Market Effect. One of the ways producers face uncertainty is through having the supply curve shift randomly. The supply curve shifts randomly to either the left or the right due to unexpected conditions depending on how the weather is, if there is any insect infestation, or even how many yields a farmer can grow. The figures above graphically represent the different types of shifts the supply curve does, depending on the unexpected condition. For example, let’s say that there is good weather. The supply curve will shift to the right from S0 to SG. This will decrease the price from P0 to P1 and will increase the quantity from Q0 to Q1. On the other hand, let’s say we have bad weather and there is a drought. The supply curve will shift to the left from S0 to SB. This will increase the price from P0 to P2 and will increase the decrease from Q0 to Q2.
Another way that producers of Crop Insurance face uncertainty is through the demand curve. Just like the supply curve, the demands curve can also shift randomly either the left or the right due to unexpected things like how high or low hen price s of the crop is, economic growth, and low income. The figures above graphically represent the different types of shifts the demand curve does depending on the unexpected condition. For example, let’s say that there is an economic growth. The demand curve will shift to the right from D0 to DG. This will increase the price from P0 to P1 and it will also will increase the quantity from Q0 to Q1. On the other hand, let’s say there is not an economic growth and there is low income. The demand curve will shift to the left from D0 to DB. This will lower the price from P0 to P2 and will decrease the quantity from Q0 to Q2.
However, if there is a Crop Insurance policy attached to the Market Effect, then it will protect the producer. The graph above illustrates how Crop Insurance insures the farmer against bad weather and overall a drop in revenue. At first, the scenario starts out normal, since there is bad weather, the supply curve will shift to the left from S0 to SB. Additionally, the guaranteed revenue is the multiplication of P0 and Q0. However, since the price increased from P0 to P1, the new guaranteed revenue will represent both the blue and the yellow portion of the graph. Since there was a drought then the actual revenue would be represented by the blue area of the graph. This of course creates the yellow part which is the indemnity of the farmer.
On the other hand, the graph above shows what will happen if the supply dropped and demand also dropped but instead of the price going up, the price decreases. At first, the scenario starts out. Since there is bad weather, the supply curve will shift left from S0 to SB and the quantity will decrease from Q0 to Q. However, in this scenario the price will decrease from P0 to P1. Since the price decreased, the guaranteed revenue which is highlighted by the blue and yellow portion in the graph does not decline. This is because the price and quantity has to be equal to or be more than P0 and Q0. This gives an actual revenue of P1*Q1, which is the blue portion of the graph. In addition, the indemnity will be the yellow portion of the graph.
Additionally, the guaranteed revenue is the multiplication of P0 and Q0. However, since there was a drought then the actual revenue would be the multiplication between P1 and Q1. This of course creates the yellow part which is the indemnity of the farmer.
Conclusion
The Market Effects for producers are uncertain in both the supply and demand curve because of unexpected events. However, Crop Insurance can ease the burden. Although, one of the key characteristics of Crop Insurance is Moral hazard and Adverse Selection, Crop Insurance is a type of insurance that farmers purchase in order to protect themselves financially and their crops against unfortunate events like droughts. Crop Insurance takes the financial stress out of the farmer when an unfortunate event happens even if the prices fall.
Work Cited
- Roberts, Michael J, et al. “Estimating the Extent of Moral Hazard in Crop Insurance Using Administrative Data.” Usda.gov, 6 Jan. 2006, naldc.nal.usda.gov/download/36723/PDF.
